Sunday, September 14, 2014

The Fed's New 4% NGDP Target

Lars Christensen appeared to congratulate the Fed on the 4% nominal GDP level target it has been following since 2009.    I have noted this apparent new path before, particularly during the debate about the fiscal cliff.   Some Keynesians argued that the tightening of fiscal policy must have prevented what would have been an expansion in nominal GDP due to various types of private spending recovering.   I noted that the data looked like the economy was on a stable growth path.   Still, I have continued to argue for a Reagan/Volcker nominal recovery before setting on a new 3%  growth path for nominal GDP.

Sumner responded by saying that in 2009 he would have been unhappy that the Fed had shifted to a lower growth path for nominal GDP, as well as a lower growth rate.    And further, he worries that the Fed is still not really targeting the level of nominal GDP.   If there is some shock, then nominal GDP with shift to a new growth path--one consistent with inflation remaining at 2%.    This would probably be close to nominal GDP growth at 4%, but the level could be anywhere.

Christensen's more recent post on the issue suggests that it is time to forget the old growth path and instead propose that the Fed formally commit to remaining on the growth path for nominal GDP that has been blazed since 2009.   In other words, he is rejecting any partial, much less total, return to the growth path of the Great Moderation.

If we believe the more recent estimates of real output being 2 percent below potential, then staying on the new growth path would require an approximate 2 percent deflation of output prices and matching decrease in wages an nominal incomes.   Presumably, something like zero inflation for a year and holding the line on pay increases to something like 1% should allow the needed adjustment in prices and wages to the new growth path to occur more gradually--over a single year.

Why not just shift the growth path up by 2 percent?   Of course, if you believe that the estimates of potential output are too high--perhaps real output is at potential now--then the upward shift in the growth of nominal GDP would at best just general a jump in the price level and at worse create an unsustainable boom in  real output.

Of course, the Fed's actual policy is that just such a jump in nominal GDP would be desirable, if it could occur with inflation remaining on target--in the medium run, anyway.   The Fed won't commit to shifting nominal GDP up to the higher path.   Nor will they commit to keeping it on the current path.  They instead will keep monetary policy accommodative--interest rates "relatively" low--until the output gap closes consistent with inflation remaining pretty much on target.    And so, an upward shift in nominal GDP is still a possibility.

I think the new 4 percent growth rate is desirable, but I continue to favor an upward shift in the growth path of nominal GDP.   Is it really 2 percent?   How much faith do I have in the potential output numbers?  Still, the more time that passes, the more I will have to adopt Christensen's view--have the Fed make a commitment to the new path for nominal GDP.    If the Fed continues with flexible inflation targeting and we have another recession, it could be worse.   And are we sure the Fed has learned its lesson regarding adverse supply shocks?    There are advantages to shifting to a new regime--even if some deflation is needed to get real output back to potential.

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